Feb. 8, 2024
Dear SEC,
As a retail investor, I would like to state my strong opposition to proposal SR-OCC-2024-001 for the following reasons.
1. The redaction of specific details, especially related to the calculation of parameters and margin thresholds, prevents market participants from assessing the fairness and effectiveness of these measures. This raises concerns about the transparency of the OCC's risk management processes.
2. The consistent use of idiosyncratic control settings, totaling over 200 within a span of less than four years, raises questions about whether they are applied uniformly or under varying circumstances.
3. The reliance on idiosyncratic control settings, especially during high volatility, poses potential systemic risks. The OCC waiving away margin calls for Clearing Members over 50 times a year is too often to be idiosyncratic. If these adjustments become a routine response, it indicates a lack of robustness in the overall risk management framework.
4. The high frequency of adjustments in response to market conditions or specific challenges faced by Clearing Members raises concerns about the stability and predictability of the OCC's risk management practices. Such frequent interventions indicate a dynamic and reactive approach to risk management, leading to uncertainties in how risk is assessed, mitigated, and communicated to market participants.
5. The proposal appears to make Clearing Members, even those poorly managing risks, de facto "Too Big To Fail," risking financial system stability. If we've learned anything from history in our financial markets, Too Big To Fail is never a good thing, especially for retail investors.
6. The reliance on GARCH parameters for forecasting risk and setting margin requirements assumes the accuracy and relevance of these parameters. Any shortcomings in the model or miscalculations could lead to inadequate risk coverage.
7. The FRM Officer, tasked with protecting OCC's interests, may paradoxically function as an administrative rubber stamp for reducing margin requirements, potentially compromising market risk protection as they seek to protect the Clearing Member from failure to protect the OCC.
8. Concentrating significant decision-making authority in a single individual, such as the FRM Officer, to approve the implementation of idiosyncratic control settings may inherently create the risk of conflicts of interest or potential abuse of power in their role.
9. The policy outlines general guidelines for the duration of idiosyncratic control settings, the discretionary power given to the FRM Officer to adjust the duration based on unforeseen situations introduces an element of uncertainty.
10. The proposal exposes the OCC to financial risks by potentially depleting its pre-funded financial resources in the event of a sufficiently large Clearing Member default - aka - the OCC’s Clearing Member Default Rules and Procedures, losses are allocated first to the OCC's own pre-funded financial resources ("skin-in-the-game") before utilising clearing fund deposits of non-defaulting firms. In the event of a sufficiently large Clearing Member default, if both the margin deposits and clearing fund deposits are depleted, it automatically poses a financial risk to the OCC.
11. If approved, the rule would undermine the first line of protection outlined in OCC's default rules and procedures—margin collateral from at-risk Clearing Members. This contradicts the usual risk management strategy of increasing collateral for higher-risk scenarios.
12. Focusing on potential liquidity issues for non-defaulting Clearing Members indicates the OCC's concern about risks depleting its pre-funded financial resources, raising questions about the sustainability of its risk management approach.
I would suggest the following improvements instead:
* Strengthen and enforce margin requirements in alignment with the risks inherent in Clearing Member positions, as opposed to reducing these requirements. Clearing Members should be incentivised to structure their portfolios to withstand challenges posed by stressed market conditions and long-tail risks. The current rule proposal creates a potential incentive for Clearing Members to pursue a "Too Big To Fail" strategy, exerting pressure on the OCC through heightened risk and leverage, which may result in more frequent implementation of idiosyncratic controls, privatising profits, and socialising losses.
* Introduce external auditing and supervision as a "fourth line of defense," enhancing transparency and proactive risk management with public reporting.
* Incorporate public input through consultations and hearings in the rule making process, fostering inclusivity and making regulatory actions more representative of diverse perspectives.
* Advocate for public accessibility of stress testing results, showcasing the effectiveness of risk management measures and building trust among market participants.
* Consider establishing an external oversight committee comprised of industry experts, academics, and investor advocacy representatives to ensure impartial evaluation and scrutiny of risk management practices.
* Reorder the Loss Allocation waterfall by prioritising Clearing fund deposits of non-defaulting firms over OCC's pre-funded financial resources and the EDCP Unvested Balance. This adjustment aims to foster self-regulation among Clearing Members, ensuring they actively monitor and enforce risk management measures, as their Clearing Fund deposits would be at risk after a suspended firm's deposits are depleted. The proposed modification enhances protection for both the OCC, a Systemically Important Financial Market Utility (SIFMU), and the public by allocating losses to the clearing corporation after Clearing Member deposits are exhausted, thereby reducing the potential need for a bailout of the clearing agency.
* Enhance transparency requirements, ensuring clear and accessible disclosure in reporting and decision-making processes related to risk management measures. This includes public disclosure of how the OCC will ascertain parameters in its proprietary system for calculating margin requirements during high volatility, with specific details on how these parameters will be calculated.
* Strengthen oversight mechanisms, involving regulatory bodies more actively to maintain accountability and address emerging risks during periods of heightened market volatility.
* Provide clear guidelines for the application of idiosyncratic controls, preventing misuse and proposing a structured evaluation framework for consistency and full disclosure for public reviewal.
* Consider establishing an external oversight committee comprised of industry experts, academics, and investor advocacy representatives to ensure impartial evaluation and scrutiny of risk management practices.
Thank you for allowing me to share the reasons for my strong opposition to the subject proposal. Please feel free to contact me should you have any questions.
Sincerely and respectfully,
Bill Dudenhoefer
Erie, Pennsylvania